ECB to change how it supplies banks with vital liquidity

With the impending announcement of its Operational Framework Review, the European Central Bank (ECB) is approaching a pivotal point in its history. The guidelines guiding the ECB’s future liquidity injections into the commercial banking sector will be decided upon after this review.

The framework is extremely important because it determines how the central bank affects short-term interest rates and communicates its monetary policy positions to banks and the economy of the entire eurozone. In an effort to promote inflation and economic growth, the European Central Bank (ECB) has been pumping large quantities of cash into the system for more than ten years.

But there is a problem with the way things are right now. The eurozone’s debt crisis and previous attempts to increase inflation left behind a surplus of liquidity that contrasts with the current economic reality of rising interest rates and surging prices. Lenders are depositing these money back at the ECB overnight at a rate of four percent, which results in billions of euros in annual fees from this surplus liquidity, which amounts to an astounding 3.5 trillion euros.

The interbank lending market has been severely hampered by banks’ current reliance on the ECB for liquidity. Now, policymakers are thinking about how to boost interbank lending again, possibly with the ECB serving as a lender of last resort.